Why CSL Fell Sharply Yesterday

This story features CSL LIMITED. For more info SHARE ANALYSIS: CSL

FNArena has received a number of enquiries as to why the big CSL share price fall yesterday. For the less experienced, here is the explanation.

-Yesterday's share price fall is not a negative reflection on CSL
-The mathematics of share price dilution
-The fundamentals of a capital raising

By Greg Peel

There was nothing untoward about CSL’s ((CSL)) -8%-plus share price plunge yesterday. It did not imply there was something terribly wrong with the company, rather it’s all about mathematics.

CSL has agreed to acquire Swiss pharmaceutical company Vifor Pharma for US$11.7bn. While some of that cost will be covered by cash and debt, the rest required a capital raising – the issuing of new shares – in this case to the tune of A$6.4bn.

When a company raises equity via the issue of new shares, this leads to share price “dilution”.

The Maths

Let’s say a company has one million shares on offer and is trading at $100, implying a market capitalisation of $100m. That company then decides to raise more capital, equal to 10% of the existing number of shares.

The result will now be 1.1 million shares on issue for the same company, which all things being equal implies the share price must adjust down by -10% to $90.

In order to counter this dilution, the company will typically offer the new shares at a discount to the last share price. Or if the company leaves it to the market to decide what the price should be (as was the case for CSL), the market will factor in the dilution impact and price accordingly.

So if you are an existing shareholder and you buy the new shares at the -10% discount, you’re back to where you started, albeit you still have to come up with the cash. If you don’t participate, your shares are now worth -10% less.

Your decision will be based on your view as to whether the reason behind the capital raising is a good one or not.

Ceteris Paribus

I did say in our example “all things being equal”. Of course they rarely are. There are a number of reasons why a company might raise new capital.

A number of companies were, through no fault of their own, hit hard in 2020 when covid arrived. With their businesses shut down, they risked running out of money before the crisis ended, and that date was unknown.

First they would use up excess cash, then they would try to borrow money from financiers who appreciated that once out the other side, the business would be back to normal. As a last resort, they would issue new capital to keep the company afloat.

Such a raising typically comes at a big discount, on top of a big share price fall, as it is a cry for help. A prospective investor must decide whether shares at that price are a bargain on the basis of the pandemic being temporary, or whether that company is now dead in the water.

By later in 2020 and into this year we saw companies for which business had recovered, and which had survived the initial crisis by borrowing money, issuing new capital to pay off that debt.

Companies in a growth phase, such as new tech start-ups for example, may decide that with all things going well since they listed, they could really boost the business if they could invest more in growth. Despite having not yet broken even, they may go to the market for more funds via a capital raising.

The most common reason for a capital raising nonetheless, particularly for a big company like CSL that’s been around for a long time, is to fund an acquisition. Acquisitions may be “bolt-on”, implying buying a smaller company with cash or debt, or substantial, requiring more funds to meet the price. CSL’s acquisition is substantial.

As to what discount the market requires to offset the dilution of their existing shares comes down to what the market thinks about the acquisition, balanced by just how big it is. Is it a good move?

Before CSL announced its acquisition, the FNArena database had two brokers with Buy or equivalent ratings and four on Hold. Post the announcement (including the size of the raising), Citi upgraded to make three Buys and three Holds. So yes, it’s seen as a good move.

But it’s still a very big price. Hence the -8% fall in CSL shares yesterday reflected the market’s determination of the value of the acquisition, looking ahead, and the impact of dilution on the existing share price.

While in almost all cases, a capital raising will lead to a share price fall on the day, occasionally it can be the opposite. While the company may offer new shares at a discount, the market may decide the acquisition is so transformational, or game-changing for the business, the share price might actually go up on the day, despite the dilution.

In conclusion, yesterday’s -8% plunge in CSL represented a balance of maths and sentiment, and not a slur on the company.

 Existing shareholders can participate in the accompanying Share Purchase Plan, or buy from an institution unloading some of the new shares it stuck its hand up for.

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